Debt to Equity Ratio

What is Debt to Equity Ratio?

The Debt-to-Equity Ratio (D/E Ratio) is a measure of finance that indicates the relationship between a company's total debt and its total shareholder equity. It reflects the amount of debt a company is employing to fund its business in proportion to the shareholders' investment.

It is an important measure of financial leverage and risk.

Debt to Equity Ratio Formula

Debt-to-Equity Ratio = Total Debt/Shareholders' Equity

• Total Debt incorporates both short-term and long-term borrowings.
• Shareholders' Equity is the remaining interest in company assets after subtracting liabilities (also referred to as net worth).

Example

Suppose a company has:

Total Debt = ₹50 crore

Shareholders' Equity = ₹25 crore

Then,

D/E Ratio= ₹50 crore/₹25 crore = 2.0

It implies that the company has ₹2 of debt for each ₹1 of equity.

Industry Benchmarks

The ideal D/E ratio varies by industry:

Industry	Typical D/E Ratio Range
Tech / Services	0.2 – 0.5
Manufacturing	1.0 – 1.5
Infrastructure	2.0 or more

Interpretation

D/E < 1: Company is employing more equity compared to debt → Less financial risk.

D/E = 1: Equally financed by debt and equity.

D/E > 1: Firm is employing excess debt over equity → Increased financial risk but potentially greater returns.

Why is it Important?

1. Risk Assessment
   Excessive debt can stretch a firm's finances, particularly when profits decline.

2. Creditworthiness
   Banks utilize it to gauge the firm's repayment capability of loans.

3. Investor Insight
   Indicates the extent of aggression of the firm in employing borrowed capital.

4. Capital Structure Decisions
   Assists management in making the correct proportion of debt and equity financing.

Limitations

• Ignores Interest Rates: Does not indicate how costly the debt is.
• Balance Sheet Based: Might not depict current market values.
• Different Accounting Practices: May complicate comparisons.